Today we are going to look at K W Nelson Interior Design and Contracting Group Limited (HKG:8411) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for K W Nelson Interior Design and Contracting Group:
0.25 = HK$32m ÷ (HK$153m - HK$28m) (Based on the trailing twelve months to June 2019.)
Therefore, K W Nelson Interior Design and Contracting Group has an ROCE of 25%.
Is K W Nelson Interior Design and Contracting Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. K W Nelson Interior Design and Contracting Group's ROCE appears to be substantially greater than the 11% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, K W Nelson Interior Design and Contracting Group's ROCE is currently very good.
You can see in the image below how K W Nelson Interior Design and Contracting Group's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. If K W Nelson Interior Design and Contracting Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
K W Nelson Interior Design and Contracting Group's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
K W Nelson Interior Design and Contracting Group has total assets of HK$153m and current liabilities of HK$28m. As a result, its current liabilities are equal to approximately 19% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From K W Nelson Interior Design and Contracting Group's ROCE
With low current liabilities and a high ROCE, K W Nelson Interior Design and Contracting Group could be worthy of further investigation. K W Nelson Interior Design and Contracting Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.